Question: This problem has three parts. This is PART B (its conditions, repeated below, are the same as before, andits solution is independent from Part A).

This problem has three parts. This is PART B (its conditions, repeated below, are the same as before, andits solution is independent from Part A).

Allied Investments (AI) is a diversified company with two operating divisions:

DivisionPercentage of Firm ValueCosmetics40%Mining60%

AI has no debt on its balance sheet. To estimate the cost of capital for each division, AI has identified one principal competitor for each of its two divisions. The competitors are pure-plays, i.e., they are not diversified and operate in only one industry each, and they maintain a constant Debt-Equity ratio at all times. Assume that the debt of the two competitors is riskless.

CompetitorEstimated Equity BetaDebt/(Debt+Equity)Nova Cosmetics0.90.20Blackshaft Mining1.40.10

Assume these betas are accurate estimates and that the CAPM holds. Further, assume the risk-free interest rate is 5% and that the expected return on the market portfolio is 12%.

PART B:The cost of capital of AI as a whole is:

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